Balancing Small Silver with Big Payoffs: David Morgan

Source: Brian Sylvester of The Gold Report (12/14/11)

David Morgan, publisher of Silver Investor, likes the balanced risk and growth that midtier companies provide, but even he can't resist the pull of having a speculative pick pay off. In this exclusive interview with The Gold Report, Morgan talks about the tenets he lives by when investing in mining companies, be they small-cap or midtier or billion dollar companies.

The Gold Report: David, in August you predicted that the silver price could go as high as $75 an ounce (oz). It was recently at about $32/oz. Where is it along the path to $75/oz?

David Morgan: I don't see the silver price going above the $50/oz level in 2011. In other words, the top is in for this year, and has been for some time. I do see silver's price going above $50/oz in 2012. I forecast $65–75/oz silver by the end of 2012. I don't foresee a big rush into price appreciation for gold or silver in the first quarter of 2012 (Q112), which is seasonal. Typically, there is a very strong boost to the price of metals in the first quarter of every year. However, this year I'm suspect because of what's going on in the Eurozone and all the paper pushing between the central banks of the world. I'm reserved about what's going to happen over the next three months.

TGR: What did you think of the recent move by central banks in the U.K. and Canada getting together to boost liquidity in the markets? It seemed to push up the gold price a bit.

DM: It was what I call "old school." I'm showing my age, but we used to avidly watch the U.S. money supply. When there was a significant increase in the money supply, the gold price would reflect that because it is more dollars chasing a fixed amount of goods. It's a clear indicator that papering over the problem is not a solution and gold is shouting that loudly. The increase in M1, M2 or M3 (not provided by the Fed anymore) is looked at, but not with the intensity it was in the 1970s.

TGR: In the November issue of Silver Investor, you report that China could become a significant holder of European debt. While any such move would devalue China's significant holdings of U.S. Treasuries, it would provide leverage for China's efforts to form a new global currency backed in part by gold. Could you expand upon that idea?

DM: China as a nation has become the creditor of last resort because it has money to recycle. The more debt that it owns, the more control it has over the debt. China would have a lot of leverage in any default negotiations. There was a conference about a gold-backed yuan about a decade ago. The idea about a gold-backed currency is probably going to take place at some point in the future. China has bought more gold all along than they publicly admit, but the amount is far too small at this point to do any real gold backing to their currency. The country continues to buy gold slowly and quietly. It's hard to say when China would have enough to make a viable gold-backed currency out of the yuan. That's where the negotiations would come into play.

TGR: Do you think it would take decades?

DM: It would take decades to accumulate enough to make a gold-backed yuan in the fashion China is acquiring gold now. However, if China dumped a significant amount of its money (U.S. debt) into gold at once it would drive up the price thousands of dollars an ounce overnight. Gold would go ballistic. On the other hand, China has the leverage of the debt. In other words, it says, "U.S., you owe us this much money, so what we'll do is we'll discount the debt. You send us this much gold and we'll cancel out part of the U.S. debt we hold." That is a lot of power. Remember, "The borrower is servant to the lender."

DM: The best place to be in this market, after establishing a physical metals position, is on the mining side by balancing risk with growth. I like the midtiers because this is where the greatest growth is along with mitigated risk.

TGR: Hera also tells investors to take a 24- to 36-month time horizon.

DM: All markets move up and down, including the silver market. Investors have to take the long-term view of this market. There is still a major trend to the upside, but there's going to be more volatility.

TGR: Hera tells investors to be greedy when others are fearful and be fearful when others are greedy.

DM: I was getting fearful while others were getting greedy when silver was around the $35/oz level on its way to $50/oz. I cautioned investors that if they had to buy silver at that level to only buy some because the market was temporarily overdone. I was getting a lot of blowback from even some of the better analysts for being too cautious. I called the top around $48/oz and I'm pleased with that call. In other words, looking from the perspective of this interview my call was a good one, yet you would not believe the flack I took from some in this business.

TGR: Hera also says, "No excuses." If a company isn't progressing, just get out.

DM: You have to hold every company's feet to the fire. Ask what it plans to do next year and if it met its milestones last year. The idea is to strive to do everything it set out to, but if it can't then it should report it honestly and move on.

I don't really like the junior sector that much. There are a lot of companies that have gone by the wayside early in the junior mining cycle. There are still some good values out there, but it's pretty tough to call these days.

TGR: He also advises that investors pay attention to value and don't pay a premium to get on the bandwagon.

DM: I agree. For example, we did an update on Royal Gold Inc. (RGL:TSX; RGLD:NASDAQ) sometime ago that showed how valuable it was—even at an extended stock price. A well-known Wall Street stockbroker took the time to call me to say it was an over-the-top, great report. That stock has done extremely well while so many have not.

TGR: Hera also discussed the influence of inflation on real wealth. Given the hidden inflation in the market, he argues that to preserve or even grow wealth, investors have no choice but to seek higher gains of a minimum of 25% a year. What's your perspective on it?

DM: Markets are volatile. They wax and they wane. The market is in a period of consolidation. Very few stocks are reflecting their true value. It's a good time to gradually get into these stocks. They could go lower over the next few months, but they represent one of the best places to put money right now.

As far as what to expect in the future, let me just state that I agree with ShadowStats.com Editor John Williams' prediction that we have 10% inflation. There will always be some dogs (stocks) that won't move, but there should be some real gains in precious metals. If there's truly 10% inflation, there could be 25% gains in a mining equity, which would be a 15% real gain versus the true inflation rate. Once the sector gets hot again, the gains could be huge.

Presently, stocks are undervalued, which means be greedy when everyone's fearful. This is the time investors should be buying.

TGR: Some pundits are saying that the market's going to go even lower before it heads higher. Do you believe that's the case?

DM: I do, but to think that you can pick an exact bottom is an amateur's game. A professional tries to get in and accumulate while the getting is good. I'm looking at December through perhaps as late as April.

TGR: If investors are trying to reach 25% returns per year, they've got to turn to the small-cap space.

DM: Not necessarily. First, to expect those returns every year is unreasonable. However, investors could make 17% a year just by holding a good company, like Royal Gold, and writing the options on it. The options writers win 85% of the time and the option buyers lose 85% of the time. An investor could rent a stock like that out to people that want to play the options game and smile all the way to the bank—even in a downtrending market.

TGR: Nonetheless, you have some speculative buys on a handful of small-cap silver plays.

DM: Of course. Nothing is more exciting than getting a speculation right. We had Western Copper before it was renamed Western Silver, and eventually bought out by Glamis. Glamis was eventually bought out by Goldcorp Inc. (G:TSX; GG:NYSE). When you get a 4,000% gain on something, you can't help but smile.

We like some small caps. Silvermex Resources Inc. (SLX:TSX; GGCRF:OTC) is one that we've come back to. The stock did fairly well after our initial recommendation. Then we went into this financial situation that clobbered everything and Silvermex had to regroup. We sold it. We came back to it when it was very undervalued. I've done that on several companies.

TGR: Silvermex is down about 26% year-over-year right now. Is that just the market or is that fallout from the deal with Genco Resources Ltd.?

DM: It's both. The Genco deal looks pretty good on paper, but the market is giving a different vote right now.

Sometimes persistence pays off in stocks, however. I'll give you an example. We owned First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:Fkft) for a very long time. We had it at $4/share, but it was under $4/share month after month. When that stock finally caught on it went like gangbusters. We could have missed a huge move in that stock if we weren't persistent. Am I always right? No. Am I right on Silvermex? I don't know yet. Does it look bad at this particular point in time? Yes, it probably does. But I know enough to know that there's a strong probability that at some point the stock will catch up.

TGR: What's your view of Silvermex's management?

DM: It's one of the better management teams out there. I know Mike Callahan, Silvermex's president who was formerly an executive with Hecla Mining Co. (HL:NYSE). I also know Art Brown, who was also with Hecla. Silvermex has a strong board. They want to make this company viable. They have something to prove.

TGR: It's trading at about $0.40/share right now. Is that a good entry point?

DM: We had it earlier than that, but it's probably OK. Investors could slowly build positions between now and April to take advantage of any further market decrease.

TGR: You've done pretty well with some of the midtiers, too.

DM:Pretium Resources Inc. (PVG:TSX) stock is up 20% after it announced a much larger, higher-grade asset. We were into the stock at around CA$8/share. It's well above CA$10/share, but it's still undervalued. We love the management. Robert Quartermain has a proven track record. Investors see a stock move and they're scared to buy it. That's incorrect thinking. A lot of these stocks that make big moves make new high after new high. How else does a stock go from $5/share to $50/share?

TGR: Pretium is up about 45% so far in 2011. How much upside is left?

DM: I think there's plenty left. Think about buying $1,000 worth of Coca-Cola stock in 1928. People worry about how much is left, but what if the stock goes up 500% or 5000%? You have to let the stock tell investors how much upside is potentially left. You don't want to sell your winners. You want to sell your losers.

DM: I do, but I don't like to use price targets because it's a no-win situation. If it makes a target and it stops at that exact price, you're a genius. If it's under that or over that then you get nothing but flack. Do I think Tahoe is undervalued? Yes.

TGR: Tahoe is planning to produce about 316.9 million ounces of silver from its Escobal property in Guatemala over the next 18 years. Do you have any doubts that it will execute on that?

DM: There are always doubts in the mining industry. There's jurisdictional risk in many South American countries. Am I confident that it'll happen? No, not today. Investors should spread out geopolitically. It's very important in today's financial climate to expect the unexpected.

TGR: The company is run by Kevin McArthur, who was the president and chief executive of Glamis Gold, which was taken over by Goldcorp, and then headed Goldcorp. It's hard to argue with that kind of track record.

DM: I'm not. You have to put a great deal of credence into that caliber of management. But the best management in the world in the wrong jurisdiction can have problems. Robert Quartermain is one of my favorite examples. He was involved in a project in Russia and got burned slightly.

It's a long-term project with a lot of hurdles to overcome in the uncertain jurisdiction of Mongolia. However, I have been to Mongolia and met with some of the people heading up the project, which will be using the coal deposit to fuel a power plant. I got a pretty good feel for how serious they are. As a speculation, it's one of the better ones.

TGR: It's a different kind of play. It's a little like the Pinetree Capital model where it takes positions in companies involved in many different resources.

DM: What I like about that type of model is that it spreads risk out. These are run by professionals that know what they're doing. That model is especially good for the retail investors who don't have the time to understand what they're buying. It's a good way to play the market.

TGR: In a response to a readers' inquiry about the frightening possibility of deflation, you replied, "I do see a deflationary scare and suggest you buy all the way through it—three to six months. These mining stocks are cheap, but could get cheaper. I do not see it as being as bad as 2008." How bad do you see it getting?

DM: The mining equities market could drop another 10%. But it's possible that the current market is as bad as it gets. I do not see the financial crisis of 2008 repeating in 2012. But something needs to be done that's going to really strengthen the financial markets and confidence in the system on a global basis. If that isn't done, I expect 2008 or worse to repeat at some point. But, again, I don't think that will happen for a couple of years.

TGR: Thanks for taking the time to share with us.

David Morgan(Silver-Investor.com) is a widely recognized analyst in the precious metals industry and consults for hedge funds, high-net-worth investors, mining companies, depositories and bullion dealers. He is the publisher of The Morgan Report on precious metals, author of Get the Skinny on Silver Investing (Morgan James Publishing, 2009) and featured speaker at investment conferences in North America, Europe and Asia.

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DISCLOSURE:1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.2) The following companies mentioned in the interview are sponsors of The Gold Report: 49 North Resources Inc., Pretium Resources Inc., Silvermex Resources Inc., Goldcorp Inc. and Tahoe Resources Inc. Streetwise Reports does not accept stock in exchange for services.3) David Morgan: I personally and/or my family own shares of the following companies mentioned in this interview: First Majestic, Silvermex, Prophecy Coal, Pretium Resources, Royal Gold. I personally and/or my family am paid by the following companies mentioned in this interview: None. David Morgan was not paid by Streetwise for participating in this story.